The Brief and Frightening Reign of Phil by George Saunders 359pp, Bloomsbury, £10.99

Not counting The Very Persistent Gappers of Frip, an illustrated children's fable, George Saunders's last UK publication was the superb short-story collection Pastoralia, six years ago. Now two books arrive at once: the 91-page title piece, which appeared in the US as a slim, stand-alone volume in 2005, and In Persuasion Nation, his new collection of short stories.

Bloomsbury's packaging of this portmanteau is calculated to reassure readers that they're getting a proper novel which, as a bonus, also "includes the In Persuasion Nation collection" (very small print at bottom of cover). Seldom has there been a more obvious concession to the truism that novels sell and short stories don't. Granted, a Saunders omnibus is a welcome thing regardless of how it's spun, but In Persuasion Nation is far superior to the novella on whose back it rides.

The titular Phil is a petty despot in the fabulous countries of Inner Horner and Outer Horner, whose citizens are cockamamie fusions of machine parts and organic matter. Motivated by jealousy of Cal, "an Inner Hornerite who resembled a gigantic belt-buckle with a blue dot affixed to it, if a gigantic belt buckle had been stapled to a tuna fish can", Phil devises a cruel and senseless system of taxation, harassment and finally genocide. Saunders's inspirations for the parable include Rwanda, Bosnia, the Holocaust and Iraq, but the tricksiness of the concept and the wackiness of the execution diminish its resonance. There are regular chuckles to be had and, against preposterous odds, episodes of eccentric poignancy, but overall this piece betrays its origins as a conceptual dare (Saunders was challenged by an illustrator friend to write a story in which all the characters were abstract shapes).

Obliged to stand in the artificially enlarged shadow of Phil is one of the bravest, funniest, angriest, most impressive short-story collections I've had the privilege to read. The title piece, "In Persuasion Nation", is perhaps the weakest of the bunch, populated by the cartoon protagonists of TV commercials endlessly re-enacting their inane humiliations. American TV is arguably beyond satire, but Saunders does his damnedest nevertheless.

Many of these stories are laced with the jargon of virtual reality, PR, computerised market research. But Saunders has no desire to be trendy; his moral purpose shines through everything he writes. Even the most chillingly depersonalised narrative here, "93990" - which starts: "A 10-day acute toxicity study was conducted using 20 male cynomolgus monkeys ranging in weight from 25 to 40kg" - harbours a fierce glow of compassion and righteous indignation.

Generosity of spirit is what Saunders longs to see in the human animal; he rarely finds it. The man in "My Flamboyant Grandson" who fights his way through the futuristic streets of New York in order to get his gay grandson to a theatre performance of Babar Sings! is a rare example of a tolerant soul. As if to counterbalance even this small triumph, the narrator of "My Amendment" is a mad homophobe promoting his Manly Scale of Absolute Gender. Indeed, the classic Saunders protagonist is hopelessly in thrall to the most deplorable forces in society at large, and expends great energy making a bad situation worse. Yet there is something strangely uplifting about Saunders's fiction, and not merely because of its quality and verve; there is a sense that the ghost of morality will continue to haunt the machine, in defiance of attempts to exterminate it.

Not all the stories throw the reader in the deep end of the post-modern maelstrom. "The Bohemians" is a conventional tale of smalltown kids growing up among elderly survivors of the eastern European pogroms. With wit, pathos and a bracing respect for human oddness, it grows steadily in power. "Christmas" shows us a labourer staking his wages on a drunken gambling match. Provoked by taunts about his incompetence as a roofer, he burns: "They were going to see. They were going to see that the long years of wrongs done to him had created a tremendous backlog of owed good luck, which was going to surge forward now, holy and personal." The outcome is not hard to guess, but Saunders handles it with his characteristic mixture of cool detachment and unbearable empathy. "Christmas" is a masterpiece of realism and belongs in anyone's ideal anthology of great short fiction.

Then there are the allegories. "Adams", which follows the deranged strategies of a concerned father to safeguard his children from a paedophile neighbour, and "The Red Bow", a chilling tale of rabies in an emotionally febrile community, are more insightful, and ultimately more useful, than any number of political tomes analysing the war on terror. Saunders has processed landfill sites full of newspaper journalism and extracted the elusive essence of the conflict. And, as in all his best work, he achieves this magic distillation with cruel frankness, deep seriousness, wild humour and disarming tenderness - simultaneously. The flaws and misfires in this omnibus may be bothersome, but its achievements are extraordinary. Saunders is a frightening talent.

· Michel Faber's latest book is The Fahrenheit Twins (Canongate). George Saunders appears at the Guardian Hay festival on May 27 at 11.30am (www.hayfestival.com)